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Brexit endgame likely to see a delay

Summary: Sterling is locked back into a nervous range prior to the vote rejecting Prime Minister May’s altered deal. While the market appears comfortable that a no-deal risk is not imminent, the haziness of the timeline and outcome continues to handcuff traders.

UK Prime Minister Theresa May’s Brexit deal with its last-minute alterations was voted down with a strong majority, although less strong than the initial vote in January. Sterling was already offered earlier in the day as the market correctly assumed that attorney general Geoffrey Cox’s still dim view of the deal would result in its defeat. Sterling has not collapsed as we still don’t know what the Brexit outcome will be – although I thought it would have adjusted lower.

Apparently, some (including the author of this behind-the-paywall article from the FT) still believe that May could just yet revive her deal by twisting the arms of hardline Tories. But this appears a minority view as the noise from most quarters is that she has lost control and that Parliament must now take over. Given sterling pricing – neutral relative to levels before this week – it looks like the assumption leans very strongly for a delay rather than a no-deal exit. The immediate prospects for the latter may be ruled out as soon as today, but as we discussed yesterday, negotiating a delay period of more than about eight weeks will be challenging, given the timing of the next EU elections in late May.

For now, sterling may simply get locked into a choppy range unless May’s deal can do a Phoenix act and surprise us all with last-last ditch breakthroughs in language that can take it over the edge as Tory hardliners would prefer that versus the risk of a path to a second referendum. But the EU is already sending out unfriendly noises on the ability to negotiate any further and will demand a plan for how the UK would use any delay period – EU Commission President Juncker recently mentioned elections in that context. So, a strong vote to avoid no-deal today may boost slightly, but doesn’t eliminate the risk of a long, difficult delay period that could wear on the UK economy and its currency.

Elsewhere, the USD was on the defensive yesterday after a soft CPI print, with the core dipping lower than expected to 2.1% year-on-year and the headline at +1.5% year-over-year. Fed rate expectations are ebbing close to their lowest for the year as we await next week’s Federal Open Market Committee meeting and whether the Fed is ready to get specific on its plans for adjusting the QT schedule. Risk appetite suggests a full reversal sooner rather than later.

Trading interest

• USD longs taken off at lowered stops but the reversal hasn’t been forceful enough to encourages USD shorts. Very typical of this ugly, choppy market.

• Short EURJPY not performing either on strong risk appetite, but still like it lower if this stock rally fades. We only like maintaining a half position with a wide-ish stop above 126.50.

Trading ranges continue to shrink despite Australian rate expectations falling off a cliff in recent months, partially as rate expectations and QT expectations for the Fed have done likewise. Still, the Australia-US two-year swap spread plunged overnight to a new low for the year at negative 80 basis points. That compares with a cycle low last fall at around -90 bps. Keeping the AUD from melting lower are likely strong risk appetite and the hopes that a market friendly (on the headlines at least) US-China trade deal are imminent. We’re still far from believing that the lows for the cycle are in, but with no momentum in this market and pointed headline risks, trading conditions for bears are unfriendly. The 0.7000 area is the next trigger zone lower – a level we’ve trotted out numerous times in this desperately rangebound market.

USD – weak CPI, strong US Treasuries and strong risk appetite are not good for USD prospects. Is the market gunning for a US-China trade deal or an FOMC meeting announcing the coming end of QT... or both?

EUR – the euro rising on negative developments from sterling and the greenback more than on anything the euro has to offer in the positive column.

JPY – positive risk sentiment has hit the pause button for JPY rally prospects, though weakening global yields are supportive. It's hard to believe with the US equity rally threatening to blow the roof off resistance in the S&P 500 (already done in Nasdaq), that the US 10-year yield is at a local low and only a few basis points above the spike low during the massive risk sell-off in December. Both risk-off and lower yields are needed to get USDJPY to punch lower from here.

GBP – as we discuss above, two-way risks remain, and a strong rejection of a no-deal vote in Parliament today won’t necessarily sustain a rally as the endgame remains uncertain.

CHF – the franc taking its cue more from risk appetite than Brexit concerns – but we’re still so bogged down in the range in EURCHF that we struggle to pay attention here.

AUD – Australia weakening overnight on an ugly decline of several points in its main Consumer Confidence survey, which correlates in many economies with employment prospects. This adds to the risk of the RBA having to fold on its optimistic outlook. Australia’s short rates plunged to a new low for the cycle, declining some five basis points lower overnight.

CAD – USDCAD needs to find support here around 1.13350.

NZD – the kiwi thriving at the weak Aussie’s expense, though we are uncomfortable with the relative pricing of the two currencies, given the RBNZ will likely follow on cutting rates if the Reserve Bank of Australia leads. 1.0250 is the next zone of interest in AUDNZD.

SEK – the krona avoiding much of a beating despite a small CPI miss yesterday. Still the market is beginning to price out the Riksbank’s ability to raise rates, given the European Central Bank's new guidance. EURSEK is perhaps only in danger of squeezing through 9.60 on data developments or an ugly round of risk-off.

NOK – NOK higher versus the euro, but the follow-up price action was a bit disappointing for NOK bulls given the strong risk sentiment and increased pricing of a 25 bps hike (you ready that correctly) at next week’s Norges Bank after this week’s strong CPI print and a solid Regions survey yesterday.

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